Weekly Market Update 01/26/2020Posted Jan 27, 2020
The S&P 500 declined -1.03% this week with Friday's close at 3,295.47. This marks the first weekly decline of -1% or more since September of 2019, and just the third weekly decline over the last sixteen weeks. This week's price action was somewhat of an opposite to recent trading weeks; we saw early week strength and late week weakness. The index traded as high as 3,337.77 on Wednesday, a fresh new all-time high, only to then trade down to 3,281.53 on Friday, a decline of -1.68%. Virtually all of this decline was attributable to Friday's price action where the S&P 500 declined -0.90%, its largest daily decline since October of 2019.
Friday's price action recorded as a large "bearish outside reversal bar" and "bearish engulfing candlestick". Friday's open at 3,333.10 was essentially right next to our all-time high, and the index essentially did nothing but trade lower all day on Friday. We've encouraged the S&P 500 to take a "breather" for about a month now. Naturally, we can't help but wonder if this week's downside reversal was the start of a real pullback for the S&P 500.
In last week's Update we wrote about a pullback being a "when" and not "if" situation, and pondered the question of what type of pullback we should expect: a normal, healthy -2% or -3% decline, or something more violent, along the lines of a -5% to -10% downdraft. Friday's price action was rather orderly and saw some buying interest into the close. It's still impossible to know whether we're looking at a normal, healthy -2% or -3% pullback, or something more violent. Perhaps it's influenced by whether the coronavirus is relatively normal, or something more violent (click here).
While the coronavirus is front and center at the moment, it's corporate earnings that will hopefully take center stage next week. 146 companies report earnings on Monday, and another 249 report on Tuesday, with perhaps none being more important than that of Apple, the single largest holding in both the S&P 500 and Nasdaq Composite. Given the S&P 500's incredible advance the last 3 months, it's imperative corporate earnings meet the collective expectations of market participants. It's clear participants have been pricing in an upside reflation of corporate earnings since last October.
Naturally, if earnings don't meet the market's expectations, participants have to "correct" their forward-looking expectations. This is how the price of the S&P 500 "corrects" (i.e., declines) to adjust for the disparity between what participants were expecting on the earnings front, and what actually was announced on the earnings front. Put simply, if earnings come in strong this week, the S&P 500's advance will have its "aha" moment where the price action the last three months makes sense. If earnings disappoint, collectively, then we'd expect to see the S&P 500 trade down toward the ~3,200-3,250 price region over the week ahead.
Finally, as we head into next week the S&P 500 remains "overbought" across a multitude of indicators and time periods. The 50-day moving average of the S&P 500's 14 trading day relative strength index (RSI) closed on Friday at 69.15. It's only been at and around this level on three separate instances over the last 10 years - in advance of 2011's correction, in advance of 2012's pullback, and in advance of 2018's February swoon. Not exactly the best of company.
On a weekly basis, the S&P 500's 14-week RSI closed at 73.07, which also remains "overbought". Quantitatively, this week recorded as a calendar week that saw the S&P 500 decline -1% or more with RSI also closing above the 70 threshold. Since 1970, we've only seen this happen 13 prior times, so it's very rare. In the prior 13 samples, the S&P 500 has closed higher one week later 8 of 13 instances, but it has then closed lower two weeks later 8 of 13 instances.
As always, there's nothing that transpired this past week that's consistently predictive of what lies ahead. Speculatively speaking, we continue to believe the S&P 500 will clear its "overbought" condition over the weeks ahead, by either trading down into the ~3,150-3,200 price region or by trading sideways and consolidating, before beginning the next leg higher.
S&P 500 Primary Trend - Up
The S&P 500 is higher by 2.00% thus far for the month of January. As long as the index doesn't close the week ahead lower by -2% or more, January will record as the fifth consecutive monthly advance for the S&P 500. If the S&P 500 doesn't decline by -1% or more over the week ahead, the index will record its fifth consecutive monthly advance of 1% or more.
Historically speaking, a five-month winning streak and/or five consecutive monthly advances of 1% or more are fantastic signs of a continued advance for the S&P 500 over the forward 3-, 6-, and 12 months. This would certainly be an encouraging sign and should one or both occur we'll be sure to share the quantitative studies next week. If participants aren't eager to sell 'em over the week ahead, it's likely the hundreds of companies reporting earnings next week didn't disappoint...
The S&P 500's primary trend remains up, or "bullish", no matter how one chooses to define it. Any and all active/tactical asset allocation strategies remain turned "on", or allocated predominantly to equities. Any pullback or decline in the short term is likely to be temporary and not terminal. That is, we expect that any short-term volatility is only going to interrupt our primary uptrend, it isn't going to end it.
During uptrends, long-term investors remain best served with an equity overweight across their portfolio's asset allocation and relying on strategic, or passive, investing methodologies. It's "beta" that does the heavy lifting for a long-term investor's portfolio during primary uptrends; it's where the easy money is made for long-term investors (i.e., it wasn't overly hard to make money last year with the S&P 500 higher by ~30%). Kenny Rogers popularized the phrase:
"You've got to know when to hold 'em
Know when to fold 'em
Know when to walk away"
Primary uptrends are "when to hold 'em".
However, the majority of long-term investors, especially those in their 50s and 60s (yes, you're still a long-term investor if you're 64 years old) have to "know when to fold 'em" in our opinion. At some point, the primary trend will truly transition from up to down. It will probably begin with something similar to the fourth quarter of 2018, but the difference is you won't experience a magical upside reversal like 2019.
Instead, the S&P 500 will continue to trend lower through a series of lower lows and lower highs. Those who have the discipline to "know when to fold 'em" will live to fight another day. Those who don't will likely face the most difficult challenge long-term investing can offer you - losing -30%, or -40%, or -50% of their portfolio and doing absolutely nothing in response (i.e., sticking to their long-term investing plan).
Primary downtrends, or "bear markets", generally bring about -30% declines, on average, for the S&P 500 over a ~12 month span. If you don't have a 20-30 year time horizon until portfolio withdrawals are necessary to meet retirement income needs, this type of decline in stocks is probably going to negatively affect a long-term investor's ability to achieve their stated financial goals. Remember, the S&P 500 can produce a decade with negative total returns, even if you reinvest every single dividend received.
Historically, long-term investors could choose to allocate less toward stocks and more toward bonds (something along the lines of investing their age in bonds) in order to reduce the impact of "bear markets" that are paired with a shrinking time horizon until portfolio withdrawals are necessary to retire. However, that worked when we lived in a world with interest rates, where bonds could provide a long-term investor competitive returns, both nominally and in real terms.
In 2020, we live in a world without interest rates, where going forward bonds are likely to provide very low nominal returns, and perhaps negative real returns, over the coming decade. If you're in your 50s or 60s, owning your age in bonds is essentially allocating the majority of your portfolio to earn next to nothing over the coming decade Broadly speaking, this is going to make it very challenging to meet your financial goals.
So, this means that in 2020 many long-term investors are maintaining a far greater percentage of their portfolio in stocks than most textbooks would suggest. While the luxury of hindsight suggests this has been a great decision, this also increases risk, it exacerbates the amount a long-term investor stands to lose during the next "bear market" - unless you "know when to fold 'em" or unless you diversify into alternative asset classes other than just stocks and bonds. These are the two most pressing areas we believe long-term investors should be analyzing at the moment. In other words, building a portfolio today that can thrive tomorrow requires both passive and active management at the asset class level, and more than just stocks and bonds.
Interest Rates Heading South, Utilities Skyrocketing, Real Estate Next?
The yield on a 10-year Treasury bond (UST10y) declined a whopping -7.61% this week with Friday's close at 1.70%. Friday's close is the lowest weekly close since early October of 2019. UST10y is now down -11.46% for the month of January.
Broadly speaking, crashing interest rates have historically been a bad omen forward- looking, both economically and in forecasting the future price action of the S&P 500. However, over the last decade crashing interest rates have essentially served to catapult the economy and S&P 500 on a forward-looking basis. UST10y's collapse to open 2020 is a sign that "TINA" (an acronym for "there is no alternative") is alive and well.
The top half of the chart below is a weekly chart of UST10y the last decade. The bottom half is the ratio of UST10y to the S&P 500's dividend yield. At the moment, the S&P 500 is yielding almost the exact same interest as a UST10y - even at all-time high prices and nosebleed valuations. We've never seen this before...we live in unprecedented times.
Looking forward, market participants in the fed funds futures market are starting to price in the probability of further interest rate reductions here in 2020. The probability of the Federal Reserve lowering interest rates in November moved to 58.78%. The probability of the Fed lowering interest in December moved up to 67.83%.
Lower interest rates in the present across the yield curve help increase the relative attractiveness of dividend-paying equities, specifically the utilities sector. While UST10y yields 1.70%, the S&P 500 Utilities Sector Index (SPU) yields roughly 3.5%, two times that of UST10y. SPU has now closed higher a whopping 11 days in a row and has gained 7.07% the last 11 days.
SPU gained 2.40% this week with Friday's all-time high weekly close at 347.25. The Utilities Index has clearly broken to the upside and is now up 5.75% thus far for the month of January. Utilities leading to the upside, with the S&P 500 on the verge of a five-month winning streak paired with an all-time high monthly close, is also not the norm. Again, we live in unprecedented times.
SPU's daily 14-period RSI closed Friday at 84.58. We can count on one hand the amount of times this has occurred the last two decades.
So, as bond prices have ticked back up toward all-time highs, interest rates have collapsed. Participants, collectively, have been eagerly bidding utility stocks in response. The takeaway here is that "TINA" is alive and well, and participants are starving for yield.
While SPU has garnered the most attention, the S&P 500 Real Estate Sector (SPRE) closed at an all-time high weekly close this week too, and is now in position to breakout to the upside above 2019's high of 247.02. Perhaps it's SPRE that's on deck to surge with UST10y seemingly on the verge of retesting 2019's lows in the 1.50% region. Perhaps it really is, "lower for longer" on the interest rate front. The contrarian in us remains skeptical, but the price action in the present is difficult to argue.
As always, another exciting week awaits.
Steve, Rick, and the AlphaCore team
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